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Engineering Firm Entitled to Section 179D Deduction Allocated from Federal Facility

(Parker Tax Publishing February 2023)

The Tax Court held that the shareholders of an S corporation that contracted with a government entity to supply and install components of a federal building's heating, ventilation, and air conditioning system were entitled to claim an energy efficient commercial building property (EECBP) deduction under Code Sec. 179D for the installation, but their deduction was limited to the amount billed for the work. According to the court, the S corporation was entitled to the deduction because (1) the property installed was EECBP within the meaning of Code Sec. 179D(c)(1), and (2) the chief officer of maintenance and operations at the federal building properly allocated the amount of the Code Sec. 179D deduction to the S corporation as the person primarily responsible for designing the EECBP. Johnson v. Comm'r, 160 T.C. No. 2 (2023).


Edwards Engineering, Inc. (Edwards), an S corporation, is in the business of designing and installing heating, ventilation, and air conditioning (HVAC) systems and process systems and is a licensed Illinois engineering firm. Edwards employs several professional engineers who are licensed in Illinois as well as other states. In 2013, Michael Johnson, Brant Lieske, Todd Lieske, and Scott Lieske owned all the shares of Edwards.

In March 2012, Edwards entered into a maintenance contract with the U.S. Department of Veterans Affairs (VA) to provide maintenance services with respect to the HVAC systems at a VA Hospital in Hines, Illinois (Hines VA). Michael McCrary was the Chief of Maintenance and Operations at Hines VA and was involved with the procurement of goods and services for Hines VA. The maintenance contract applied to several buildings on the Hines VA campus, including Building 200. The Edwards employees primarily responsible for providing services at the Hines VA campus were Robert Paul and Ron Carpenter. Paul was responsible for the overall project management at Hines VA. Carpenter, an experienced HVAC technician, was the site supervisor at Hines VA acting on behalf of Edwards.

In September 2013, Hines VA requested that Edwards provide a quote for replacing the control systems for the S4/S5 air handling units in Building 200. At that time the existing control systems that served the S4/S5 air handling units and several other floors had become obsolete, and the system was not functioning properly. In order to perform the work for the S4/S5 air handling units project, Edwards obtained the technical information for the existing system, including control prints, mechanical prints, and floor plans. Edwards also obtained the original sequence of operations for the existing mechanical systems in Building 200, conducted a full assessment of the existing system, and modified the sequence of operations as necessary. The original sequence of operations for the existing system was designed by another consultant in 2009 or 2010 as part of previous HVAC upgrade work for Building 200.

Edwards provided a quote to Hines VA for the replacement of the control systems for the S4/S5 air handling units. The statement of work for the S4/S5 air handling units project called for Edwards to "furnish all labor, materials, tools, and equipment and parts necessary to replace the existing Control systems operating S/4/S/5 air handling units and install new Johnson Controls Building automation system." Paul signed the contract modification on behalf of Edwards to proceed with work on the S4/S5 air handling units project. Hines VA paid Edwards $304,640 for the work done on Building 200 in 2013.

Energy Efficient Commercial Building Property Deduction

Code Sec. 179D provides a deduction with respect to energy efficient commercial building property (EECBP). Rather than having to capitalize building-related expenditures, Code Sec. 179D allows taxpayers an immediate deduction with respect to EECBP. A number of requirements must be met in order to take the deduction. Generally, EECBP includes property installed as part of (1) interior lighting systems, (2) heating, cooling, ventilation, and hot water systems, or (3) the building envelope, and which is certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 50 percent or more in comparison to a reference building which meets certain federally mandated minimum requirements, referred to as Standard 90.1-2001.

Prior to the issuance of regulations under Code Sec. 179D, the IRS issued interim guidance in Notice 2006-52 and Notice 2008-40. Notice 2006-52 provided that, before claiming a Code Sec. 179D deduction, the taxpayer must obtain a certification that meets the requirements of Code Sec. 179D(d)(5) and (6). Code Sec. 179D(d)(5) provides that the certification must include an explanation to the building owner regarding the energy efficiency features of the building and its projected annual energy costs. In Notice 2008-40, the IRS set forth guidance interpreting the requirements for the allocation of Code Sec. 179D deductions for government-owned buildings under Code Sec. 179D(d)(4). Before 2023, Code Sec. 179D(d)(4) provided that, in the case of EECBP installed on or in government-owned property, the IRS must issue a regulation to allow the allocation of the deduction to the person primarily responsible for designing the property in lieu of the owner of such property. Such person is treated as the taxpayer for purposes of Code Sec. 179D.

Observation: After December 31, 2022, the 2022 Inflation Reduction Act amended Code Sec. 179D(d)(4) to provide that this special rule allowing an allocation of the Code Sec. 179D deduction is available to a "specified tax-exempt entity," which generally includes federal, state or local government or a political subdivision thereof, Indian tribal governments, and tax-exempt organizations.

Edwards engaged Alliantgroup, LP (Alliantgroup) to conduct an Energy Efficient Commercial Building Tax Deduction Study (study) with respect to Building 200. Alliantgroup sent Johnson an allocation letter and requested that Edwards have McCrary sign the allocation letter. McCrary signed it on a signature line labeled "Signature (VA Representative)." The allocation letter stated that "the owner of the Building allocates the full federal income tax deduction available under Section 179D attributable to the HVAC and hot water systems to Edwards Engineering, Inc., for their work on the Building." Attached to the allocation letter was a table which stated the placed in service date and the cost of the property installed in Building 200 with respect to the projects at issue. After obtaining the allocation letter, an Alliantgroup employee and a professional engineer, Adam Goldberg, performed the energy modeling with respect to Building 200. Goldberg completed and signed a certificate of compliance related to Building 200 of Hines VA.

In 2014, Alliantgroup sent a letter to Hines VA, addressed to McCrary, informing Hines VA that Alliantgroup had completed the study for Building 200 and determined that Edwards had been allocated a Code Sec. 179D deduction in the amount of $1,037,237. The letter also provided the projected annual energy costs for Building 200 and a list of the energy efficient features installed in Building 200.

Edwards claimed a Code Sec. 179D deduction of $1,073,237 on its 2013 tax return. The IRS disallowed the deduction in full. According to the IRS, Edwards did not satisfy the requirements of Code Sec. 179D(c)(1)(D) because (1) the property was not installed as part of a plan to achieve the energy savings target as established by the Treasury Secretary because Code Sec. 179D(c)(1)(D) required that Edwards show both intent and specific forethought to achieve the energy savings target, which it did not show; (2) the computed energy savings were not derived from the property installed; and (3) the certification and notice to the building owner required by Code Sec. 179D(d)(5) and (6) were deficient. The IRS contended that, while Edwards computed a reduction in energy costs that purported to satisfy the energy savings target, it did not establish or otherwise verify that any of those computed energy savings resulted from the property it installed in Building 200. The IRS instead argued that the computed energy savings relied exclusively on the property installed in Building 200 as part of the original HVAC upgrade to achieve the energy savings target. Finally, the IRS argued that Edwards overstated the amount of the Code Sec. 179D deduction.


The Tax Court rejected the IRS's arguments and held that Edwards was entitled to the Code Sec. 179D deduction. With respect to the IRS argument that the property at issue was not installed as part of a plan designed to achieve the energy savings target established by the Treasury Secretary, the court found that Notice 2006-52 resolved the issue in Edwards' favor. That notice, the court stated, expressly provides that a certification is treated as satisfying the requirements of Code Sec. 179D(c)(1) if the certification contains certain information, which the court found the certification did, and nothing in the notice required a statement with respect to intent and forethought as the IRS had argued.

The court then addressed the IRS's arguments relating to the methods of calculating and computing energy savings. The Tax Court noted that, pursuant to Notice 2006-52, the percentage reduction in the total annual energy and power costs of a building is calculated by using a comparison between the proposed building and the reference building. The proposed building, the court observed, is broadly defined in Notice 2006-52 as containing the relevant systems that have been incorporated, or that the taxpayer plans to incorporate into the building. In essence, Notice 2006-52 contemplates a comparison between the proposed building as it stands and the reference building. Accordingly, the court found that the proposed building in this case properly included all the HVAC systems and components that were incorporated into Building 200 and since the property incorporated into Building 200 reduced the total annual energy and power costs with respect to the relevant systems of the proposed building by 50 percent or more in comparison to those of the reference building, the applicable requirements of Code Sec. 179D and Notice 2006-52 were met.

With respect to the certification and notice to the building owner required by Code Sec. 179D(d)(5) and (6), the court found that they were not deficient because the engineer that performed the certification credibly testified that the components installed in Building 200 represented the energy efficient features of Building 200 and satisfied the certification and notice criteria.

Finally, the court held that the Code Sec. 179D deduction was limited to $304,640, the amount Edwards billed to Hines VA for Building 200.

For a discussion of the rules relating to the Code Sec. 179D deduction, see Parker Tax, ¶96,555.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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